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July 19, 2011

Measuring Dodd-Frank’s Effectiveness and Impact on Advisors

Jury is still out on long-term effects, but reform that was meant to be bipartisan has turned into a political football.

When President Obama signed the Dodd-Frank Act a year ago, he said:

In the end, our financial system only works—our market is only free—when there are clear rules and basic safeguards that prevent abuse, that check excess, that ensure that it is more profitable to play by the rules than to game the system. And that’s what these reforms are designed to achieve—no more, no less. Because that’s how we will ensure that our economy works for consumers, that it works for investors, that it works for financial institutions—that it works for all of us.

So has Dodd-Frank been successful in achieving those goals? Will Dodd-Frank prevent another financial crisis from occurring? And what will the law mean for the investment advisory profession?

Let’s step back to recall the underlying motivation for enacting such a sweeping piece of legislation. The primary factor was to address factors that led to the 2008 meltdown. One could logically conclude that a key reason for the 2008 crisis was that regulators did a poor job enforcing existing laws and regulations and, therefore, it would be best to legislate bright lines that restrict or set limits on the size or activities of businesses, such as Glass-Steagall’s separation of investment and commercial banking.

But as my good friend Matt Fink (former president of the ICI) has written, Dodd-Frank generally rejected this approach and instead gave even more power to the regulators. Early in 2009, folks in Washington were whispering that the SEC could actually be abolished given its role in the financial crisis as well as the Madoff and Stanford scandals. But on the first anniversary of Dodd-Frank, the question now is how much bigger will the SEC grow, and how will it handle the 100 rulemakings, scores of studies, new offices and new responsibilities assigned to it by the legislation?

It’s far too early to assess whether Dodd-Frank is a “success” or “failure.” Of course, that assessment depends on who you are and what you do. In general, the larger and more complex your business is, the more Dodd-Frank could complicate your life. But even setting that aside, it’s clear that implementing core provisions of the law has been significantly delayed in large part because regulators are inundated with Dodd-Frank responsibilities and in part because the timeframes in the law were too aggressive.

The devilish details to be hammered out by various regulatory agencies will serve as the measuring stick for assessing the law’s successes or failures. But it will be months, if not years, before enough of the puzzle will be pieced

together to give us a clearer picture of how the law will affect consumers and financial institutions.

The Politicization of Dodd-Frank

Last year’s election that gave Republicans control of the House also has played a role in delaying Dodd-Frank. In fact, additional delays and even the potential rollback of certain Dodd-Frank provisions could be in store if Republicans run the table and take control of the Senate and the White House next year. This politicization of the Dodd-Frank Act seems particularly ironic in retrospect.

Early in 2009, everyone in D.C. was certain that “financial services reform” would be the one major effort on Capitol Hill where Democrats and Republicans would work together to forge consensus (unlike healthcare reform, for example). But in the end, barely a handful of Republicans in either the House or Senate voted in favor of the final legislation. Instead of a joint Democratic-Republican deal, the one-year-old law is now a political football that is being thrown about as part of a larger political agenda.

Even without knowing how all the gory regulatory details will be resolved, it’s likely that Dodd-Frank will mean more regulations, more complexity and greater oversight for virtually all investment advisory firms. That is an unfortunate result when considering that the root causes of the financial crisis were not related to the advisory profession.